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The Reserve Bank of India recently released the 19th issue of the Financial Stability Report (FSR).

About

• During the time of the global financial crisis of 2008, RBI has made many unconventional measures to protect the banking system. Liquidity support was provided abundantly so that no banks should face stress.
• The RBI since 2010 is publishing India Financial Stability Report, biannually, to assess financial stability scenario in the country. Financial stability is now one of the three important objectives of monetary policy besides price stability and credit support.
• The FSR reflects the collective assessment on risks to financial stability and the resilience of the financial system of India. The Report also discusses issues relating to development and regulation of the financial sector.

Key Points of the FSR 2019

• Global and domestic macro-financial risks
  • Geopolitical developments like BREXIT, Gulf Crisis and Trade tensions like US- China Trade War, are taking a toll on business and consumer confidence.
  • Due to reduced private consumption and widening current account deficit, domestic economy was hit.
• Financial Institutions: Performance and risks
  • Banks: Credit growth of scheduled commercial banks (SCBs) picked up, with public sector banks (PSBs) registering near double digit growth. The non-performing asset (NPA) cycle seems to have turned around as macro stress tests show gross non-performing assets (NPAs) may decline to 9 percent in March 2020, from 9.3 percent in March 2019.
  • NBFCs: Non-banking financial companies (NBFC) sector are now under greater market discipline as the better performing companies continued to raise funds while those with asset – liability mismatch were subjected to higher borrowing costs.
• Financial sector: Regulation and developments
  • The revised prudential framework on stressed assets issued by the Reserve Bank is expected to act as incentive for early adoption of a resolution plan (RP).
  • Securities and Exchange Board of India (SEBI) has introduced Guidelines for Enhanced Disclosures by Credit Rating Agencies.
  • The Insolvency and Bankruptcy Board of India (IBBI) is showing steady progress in the resolution of stressed assets.

Suggestions

• There is a need for reviving private investment demand by improving the profit prospects for the private players and at the same time, being vigilant about the spillover from global financial markets.
• There is need for greater surveillance over large NBFCs and Housing Finance Companies because failure of large NBFCs/HFCs can cause losses comparable to those caused by the big banks leading to contagion losses.

Conclusion

Overall, India’s financial system remains stable; the banking sector resilience has improved while the global geopolitical environment poses challenges.

Important Concepts and Definitions India’s Financial System - There are four main constituents of the financial system as follows: Financial Services Financial Assets/Instruments Financial Markets Financial Intermediaries Meaning of Financial Stability - Financial stability is a state in which the financial system, i.e. the key financial markets and the financial institutional system is resistant to economic shocks and is fit to smoothly fulfil its basic functions: the intermediation of financial funds, management of risks and the arrangement of payments. Contagion - Contagion is the spread of market changes or disturbances from one regional market to others. Example - The failure of Lehman Brothers in the United States. Solvency Contagion – Solvency contagion can be understood through the lens of defaults, where if A has borrowed from B and B has borrowed from C, then the default of A impacts B, which then impacts C, etc. Failure of a bank which is systemically more important leads to greater solvency and liquidity losses to the banking system. For Ex: IL&FS meltdown. Private Investment Demand – It refers to the demand by private businesses for physical capital goods and services used to maintain or expand its operations. Credit Growth – It is the increase in loans for the private sectors, individual, and public organisations  Market Discipline – It refers to the obligation by banks and financial institutions to conduct business while considering the risk to their stakeholders at the same time. For example: Banks are not supposed to give very risky loans and they have to maintain Capital Adequacy Ratio.